Blog Home / Financial Terms / Basis Risk

Basis Risk

Basis risk is the risk that the difference between the spot price and the futures price will be different than what is expected.

What is Basis Risk?

In Hedging, most of the financial positions are hedged using forwards and futures, in which the basic assumption is that the expected spot price in the future will become the actual spot price in the future. However, it doesn’t happen all the time, and this risk of getting the difference between spot prices and futures prices is referred to as Basis Risk.

Basis Risk = Spot Price – Future Price

Example

Let’s take an example of a futures contract of copper. If the contract spot price of the contract is USD 25 and the Future Price is USD 24.5, then it would be USD 0.5

Why is it significant?

It is essential because it plays a vital role in hedging the instruments well. Analysts need to ensure that the tool used for Hedging is closely linked to the hedged instrument to minimise it.

Owais Siddiqui
1 min read
Related:
Financial TermsCPD
Dow Theory: Understanding the Primary Trend and the Secondary Trend
Sagar Pujari 04 July 2022
Financial TermsFRM
What is Standard Deviation?
Owais Siddiqui 19 September 2022
Financial TermsFRM
Hedging,Types and Importance
Owais Siddiqui 19 September 2022
Financial TermsFRM
What is Hedging?
Owais Siddiqui 19 September 2022
Financial TermsFRM
Variance
Owais Siddiqui 19 September 2022

Shares

Leave a comment

Your email address will not be published. Required fields are marked *